In recent months there have been many references by politicians and economic commentators to Ireland having one of the most progressive tax systems in the OECD. These statements reference data from the OECD Taxing Wages database which provides “…an insight into the levels of progressivity in the income tax systems of OECD countries”. However, progressivity in the income tax system is often presented as the tax system as a whole being progressive, but this a different matter entirely. The overall progressivity of the tax system cannot be measured by the levels of income tax alone and a comprehensive overview of progressivity should include the effect of all taxes, charges and tax reliefs that make up the whole tax system.
The Irish income tax system is progressive using the OECD method, which means those on higher incomes pay proportionately more tax on their income than lower earners. The OECD method compares the tax liability of a single person earning two-thirds of average earnings (67%) with that of someone with a gross income of one-and-two-thirds (167%) of average earnings.
Where the difference between these two tax liabilities is high, the tax system is considered progressive, as those with higher earnings pay more as a percentage of their income than those on lower incomes. In Ireland, the person on higher earnings pays 19.3% more of his/her income on tax than the person on lower earnings, whereas this difference across the OECD is an average of 9.6%.
It is important to note that Ireland’s high progressivity score (as measured by the OECD) is a result of having low taxes on low incomes rather than particularly high taxes on high incomes. It is also important to remember that measuring the progressivity of the income tax system in this way, is based on the theoretical level of tax payable and not on Revenue data of the actual amount of tax paid.
In practice this means that the OECD data only includes personal allowances and universal cash benefits, which in this case, is child benefit. It doesn’t include tax deductions such as mortgage interest, health insurance, pension deductions or tax relief on investments, which are used to reduce the amount of tax that is actually paid (the effective tax rate). These reliefs disproportionately benefit high earners.
These tax reliefs are particularly important in an Irish context because the OECD’s Economic Survey of Ireland 2009 found that the average EU level of tax breaks in the income tax system was equivalent to 5.6% of the total tax take, whereas the equivalent number for Ireland was 18.3%. While many tax reliefs, such as those relating to property development, have been closed off, tax reliefs continue to feature strongly in the Irish tax system.
The Tax Strategy Group, for example, in its 2014 report on ‘High Income Individuals’ Restrictions’ found that those with gross incomes of €140,000 to €160,000 had an average effective income tax rate of 25%, despite paying most of their income tax at the marginal tax rate of 40%. The Revenue data shows that while there is progressivity in the Irish income tax system, in that the proportion of gross income that is paid as income tax increases as income rises, the extent of progressivity is significantly reduced by the effects of tax reliefs beyond the basic system of tax credits.
Micheál Collins’ analysis of the ‘Total Direct and Indirect Tax Contributions of Households’ in Ireland uses the Household Budget Survey data to estimate total household income tax and social insurance contributions. The lowest 10% of households pay 0.3% of their gross income in income tax, while the top 10% of households pay 23% of their gross income in income tax and social insurance (Chart 1). The average income tax and social insurance is 14%. This analysis shows progressivity in the income tax system, with contributions increasing as incomes increase.
The effects of other taxes also needs to be factored into assessing the level of ‘progressivity’ in the tax system. The OECD data relates to income tax, and this accounts for less than half (43%) of the overall tax system.
Taxes on consumption account for 35% of the tax system, while taxes on capital account for 22% of the overall tax system. Consumption taxes are also known as indirect taxes and they include VAT, excise duties, levies, local taxes and charges. This type of taxation is regressive, which means that low income families pay proportionately more of their income to these taxes compared to high income families. The lowest income households contributed over 4 times more of their income (27%) to It is important to note that Ireland’s high progressivity score (as measured by the OECD) is a result of having low taxes on low incomes rather than particularly high taxes on high incomes. Going backwards How progressive is the Irish tax system? Something wrong here GENERAL DELIVERY February 2016 51 indirect taxes than the highest income households (6%) (Chart 2). Ireland is more reliant on consumption/indirect taxes than other European countries, with an EU average of 28.5% of revenue coming from this source compared to 35% in Ireland.
Micheál Collins combines the effects of direct (income tax and social insurance) and indirect taxation (VAT, excise, levies etc.) (Chart 3). On average, households contribute 24% of their gross income in direct and indirect taxes. The lowest income households contribute 28% of gross income in taxes, most of which is made up of indirect taxes. The highest income households contribute over 29% of their gross income in direct and indirect taxes. Using this analysis, the Irish tax system can be described as regressive, as the lowest income households pay only slightly less tax (as a proportion of their income) than the highest income households. Micheál Collins concludes his analysis by stating “judging tax contributions by income taxes alone offers a limited and misleading picture of the distribution of tax contributions across society.”
With the general election campaign in full swing, all of the political parties have set out in broad terms, what they will do in relation to taxation and expenditure, if they are elected to form part of the next government. All political parties, with the exception of the Social Democrats, have stated that they will cut/abolish the Universal Social Charge (USC) and make changes to other existing taxes, while at the same time committing to increase spending across a wide range of areas. The USC is a very progressive tax that applies to different types of income with little scope to reduce the tax liability through the use of reliefs and exemptions.
Some political parties have stated that they will introduce new taxes on capital and wealth or make adjustments to Capital Gains Tax and Capital Acquisitions Tax. While there is certainly scope to increase the tax take from these sources, it is very unlikely that they will fill the revenue gap created by abolishing the USC or reducing the number of people who are liable for the USC. These promises are being made in the context of Ireland having the third lowest tax take in the EU as a % of the GDP, which was 34.4% compared to an EU average of 45.2% in 2014.
The taxation system is one half of the ‘progressive’ coin. The other side is social and economic expenditure. Government expenditure in 2014 was 38.2% of GDP in Ireland compared to an EU average of 48.2%. Lower taxes and higher disposable incomes do not necessarily make people better off, as a greater number of goods and services have to be paid for as out-of-pocket costs rather than provided as public services.
Unlike public services, the prices of private goods and services are rarely subsidised, which can make them more expensive. The cost of childcare in Ireland is an example of this as it is the most expensive in the EU. The overall system of taxation in Ireland and how we pay for public services is too heavily weighted in favour of fees and charges, which makes it regressive for families on low incomes, who often struggle to afford them, or go without.
So, how progressive is the Irish tax system?